You are considering an investment in a U.S. Treasury bond but you are

You are considering an investment in a U.S. Treasury bond but you are not sure what rate of
interest it should pay.

Assume that the real risk-free rate of interest is 1.0%; inflation is expected to
be 1.5%; the maturity risk premium is 2.5%; and, the default risk premium for AAA rated corporate
bonds is 3.5%. What rate of interest should the U.S. Treasury bond pay?
A) 5.0% B) 2.5% C) 8.5% D) 6.0%

ANSWER

A